India’s Sky-High Inflation Resembles US in Early 1980s: Pro

CNBC.com

Wednesday, 26 Oct 2011 | 8:07 PM ETCNBC.com

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A cashier rings up a customer's groceries at a Bharti Walmart wholesale store in Zirakpur, India.

Even as most central bankers around the world are pondering pausing or even lowering interest rates to spur anemic economic growth, policymakers in India are likely to hike rates on Tuesday after a two-day meeting in a bid to stem stubbornly-high inflation.

One market watcher says India’s current inflation environment resembles that of the United States in the early 1980s, drawing parallels between India’s current central bank governor Duvvuri Subbarao and Paul Volcker, who had served as Federal Reserve chairman back then.

“The fact is, Subarrao is almost acting like a one man band… setting interest rates virtually by himself,” said Robert Prior-Wandesforde, Head of India & South East Asia Economics at Credit Suisse.

"It reminds me possibly of Paul Volcker, in the United States in the early 1980s, where he kept policy for too high for too long, just to break that inflation psyche," he noted.

India has been grappling with persistently high inflation, with its wholesale price index (WPI) at a higher-than-expected 9.72 percent in September, above the RBI's 8 percent target for the nineteenth straight month, despite the central bank raising rates a dozen times since March 2010.

Volcker, as Fed chairman from 1979 to 1987, oversaw a period of rising prices, and was forced to raise rates to 20 percent in June 1981 from 11.2 percent in 1979, when inflation in the U.S. peaked at 13.5 percent in 1981. Volcker's series of rate hikes eventually brought inflation in the U.S. down to 3.2 percent by 1983.

AP

Former U.S. Federal Reserve Chairman Paul Volcker

Prior-Wandesforde said that like Volcker, the RBI's Subarrao is determined to "quash inflation expectations" and break the wage-price spiral. "Without it, India is going to be in significant trouble," he said.

A majority of analysts surveyed by a recent Reuters poll expects India's central bank to hike its key repo lending rate by 25 basis points to 8.5 percent this week before it starts pausing. But Prior-Wandesforde believes the RBI could possibly go further.

"I think we are going to get at least 25 basis points. It's certainly more likely we'll get 50 more than zero," he said. "The RBI is reacting very much to WPI inflation, and that is really key, and that I don't think will start to fall in December, in any meaningful fashion."

Prior-Wandesforde is expecting the RBI to issue a hawkish statement, and he says not to rule out the possibility of yet another rate increase after this week's meeting.